Weaker readings of leading indicators will push the sector rating lower. The promising outlook for emerging markets, such as China, is too remote to compensate for the fact that the global recovery is now behind us.

Several rounds of price increases have now reduced the leeway to set prices.

Competition will continue to increase and brands are looking for volume growth to play operating leverage. Earnings forecasts that still look for a compound annual growth rate of 15% between 2004 and 2006 seem too optimistic.

Production is concentrated in Europe (France, Italy and Switzerland) but sales are truly global: only 23% of sales are generated with European customers. Hedging will be less effective due to the prolonged weakness of the dollar.

Japanese tourism has already picked up strongly. Japanese clients represent 34% of luxury goods sales. They often buy while on holiday, but tourism has already picked up strongly. Base effects are no longer positive.

Valuations are far too stretched to absorb worsening news flow. The sector trades at a hefty 55% P/E premium to the market. This looks unjustified as the outlook is now becoming more uncertain.

-- Alain Bokobza Head of European Strategy

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